Key Takeaways

  • An indemnity bond provides financial protection in case a party fails to meet contractual obligations or causes financial harm.
  • These bonds are commonly used in construction, finance, real estate, and government projects.
  • There are various types of indemnity bonds, such as lost instrument bonds and contractor license bonds.
  • The surety (bonding company) has the right to recover paid claims from the principal under the indemnity agreement.
  • Legal and financial repercussions may follow if indemnity bond terms are not honored.
  • Understanding all obligations under an indemnity bond is crucial before signing.

Bond of Indemnity Overview

The bond of indemnity definition is an obligation in writing in which a party has agreed to reimburse the holder of the bond for an injury or loss due to a specific event or has agreed to protect a party from injury or loss related to a specific event. The bond acts as a kind of insurance policy against the failure of a party to perform in a manner that was agreed upon. If a failure to meet the terms of the bond occurs, then the party protected by the bond will be indemnified through it. When a party is indemnified through a bond, it means they have been restored to the state they were in before the failure to meet the terms of the bond took place.

When Is an Indemnity Bond Required?

Indemnity bonds are used in a range of situations to protect parties from financial loss due to contract breaches, negligence, or fraud. They’re often required when one party must assure performance or replace a lost asset.

Common scenarios include:

  • Construction projects – Contractors may need indemnity bonds to guarantee project completion or compliance with licensing laws.
  • Lost financial instruments – These bonds help individuals or entities replace lost stock certificates, checks, or bonds without risk to the issuing entity.
  • Real estate transactions – Buyers or lenders might use them to protect against defects in title or undisclosed liabilities.
  • Probate and estate matters – Courts sometimes require indemnity bonds from executors or administrators to ensure proper asset distribution.
  • Government contracts – Federal, state, and local governments may mandate indemnity bonds for vendors or contractors.

How Does an Indemnity Bond Work?

An indemnity bond acts as a safeguard against default or damage. Here’s a simplified look at how it works:

  1. Agreement Setup – The bond outlines a commitment by the principal to fulfill certain obligations.
  2. Premium Payment – The principal pays a premium to the surety company for issuing the bond.
  3. Triggering Event – If the principal fails to perform or causes a loss, the obligee (protected party) files a claim.
  4. Claim Assessment – The surety investigates the claim. If valid, the surety compensates the obligee up to the bond’s value.
  5. Reimbursement – The principal must repay the surety for any amounts paid on their behalf, including legal fees if applicable.

This structure ensures protection for the obligee while holding the principal accountable for the surety’s financial risk.

Surety Bond Indemnity

One common type of indemnity bond is a surety bond indemnity. A surety bond indemnity is a three-way agreement between the principal (the party needing the bond), the obligee (the party protected by the bond), and the surety, or underwriter (the party providing the bond­–usually a licensed bonding company). It acts as a contract guaranteeing that the principal will fulfill their obligation to the obligee. If not, then the surety will indemnify the obligee on the principal’s behalf, then turn to the principal for reimbursement for the indemnification.

Surety companies differ from insurance companies insofar as their business model does not include taking a loss in their business dealings. If a principal fails to meet the bond’s agreement, they will give the principal the opportunity to resolve this with the obligee, but if this does not occur and the surety has to step in, they will expect satisfaction from the principal. For instance, a $50,000 payment will require $50,000 in return from the principal, and if they do not get it, a lawsuit is likely to arise.

Although some surety companies only require a signature of the potential indemnitor, because of the potential for large amounts of money to be changing hands, many bond companies will ask that more stringent requirements be met before they enter into a bond agreement with a principal. These requirements could include meeting certain financial standards, having a solid business reputation, and passing a background check.

Bond companies may also require principals of the indemnifying company to act as indemnitors, as well, such as the CEO, president, and majority shareholder (in the case of corporations). Sometimes even spouses of those signing an indemnity agreement are required to sign them too. Those signing a bond will be liable for it if the principal fails to pay it, so they should take great consideration before doing so.

The surety bond agreement will always be made in writing, but since surety bonds are not legally required for private projects, their requirements will vary. For example, some surety bonds require a Social Security Number be listed, while others will require an unrelated third party to act as a witness to every signature and sign that they acted accordingly. Additionally, the protections provided by such bonds can vary from bond company to bond company, so it is best to carefully review a bond agreement with legal counsel before signing it.

Types of Indemnity Bonds

Indemnity bonds come in many forms depending on the need. Common types include:

  • Contractor License Bonds – Required by many state and local governments before issuing a contractor’s license. They guarantee ethical and lawful work.
  • Lost Instrument Bonds – Used when financial instruments like checks or stock certificates are lost or destroyed, allowing for reissuance.
  • Bid Bonds – Submitted with project bids to assure the bidder will honor the contract if selected.
  • Performance Bonds – Guarantee that a contractor will complete a project according to the terms.
  • Payment Bonds – Assure that subcontractors and suppliers will be paid by the contractor.
  • Probate Bonds – Required by courts when someone administers an estate or trust.
  • Customs Bonds – Assure payment of duties and compliance with import regulations.

Each of these indemnity bond types offers protection tailored to a specific industry or legal requirement.

Completing and Indemnity Agreement

In order to complete an indemnity agreement, there are two key steps that must be taken. First, the appropriate signatures must be gathered:

  • If a corporate indemnitor signature is required, this should be gotten from an authorized company officer, such as the corporation’s president.
  • If a limited liability company (LLC) indemnitor signature is required, this should be gotten from an authorized manager or member of the LLC.
  • If a partnership indemnitor signature is required, a signature from an authorized partner of the partnership will be necessary. Usually this is the general partner.
  • If a sole proprietor indemnitor signature is required, the owner of the sole proprietorship will have to provide it.
  • If an individual indemnitor signature is required, this should come from the individual indemnitor.

Once the proper signature is collected, the singed indemnity agreement should be returned to the surety company. Most surety companies require this to be done within two weeks of the bond’s purchase

Risks of Not Understanding an Indemnity Bond

Failure to understand or properly fulfill the terms of an indemnity bond can have serious consequences. These risks include:

  • Personal and corporate liability – The principal and often its key stakeholders may be held personally liable for bond claims.
  • Legal action – If the indemnity agreement is breached, the surety may sue to recover damages.
  • Reputation damage – Non-payment of claims can lead to loss of future business and trust among clients or public agencies.
  • Bankruptcy – If bond-related liabilities are high and unpaid, they can contribute to financial insolvency.
  • Project shutdowns – In construction and government work, bond issues can delay or halt progress.

Carefully reviewing the indemnity agreement with legal counsel before signing is critical to avoiding costly surprises.

Frequently Asked Questions

  1. What is the purpose of an indemnity bond?
    An indemnity bond protects one party from financial loss if another party fails to meet contractual obligations or causes harm.
  2. Who needs an indemnity bond?
    Contractors, estate administrators, homebuyers, business owners, and individuals replacing lost instruments may all need indemnity bonds.
  3. What happens if a claim is made on an indemnity bond?
    The surety pays the claim amount to the obligee, and the principal must reimburse the surety for the payment and any legal costs.
  4. How much does an indemnity bond cost?
    The cost varies by bond type and amount, but typically ranges from 1% to 10% of the bond’s value based on the applicant’s credit and risk profile.
  5. Can an indemnity bond be canceled?
    Some bonds can be canceled, but only under specific conditions outlined in the bond agreement. Others, especially court-ordered ones, cannot.

If you need help understanding the indemnity bond, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.